Liquidity - What does it mean and how it's used in business?
Learn what liquidity means in business,/how to calculate liquidity ratios,/and discover tips to improve your business's liquidity position.
Liquidity is the ability to convert an asset into cash while maintaining its market value. It measures a business's ability to pay short-term debts.
Types of Liquidity
There are two main types of liquidity:
- Market liquidity: How easily assets can be bought/sold
- Accounting liquidity: A company's ability to pay short-term liabilities
Most Liquid Assets
- Cash and equivalents
- Marketable securities
- Financial assets
- Accounts receivables
Least Liquid Assets
- Inventories
- Investments
- Equipment
- Real estate
- Art and collectibles
How to Calculate Liquidity
1. Current Ratio
Formula: Current Assets ÷ Current Liabilities
Ideal ratio: 1.5:1 or higher
2. Quick Ratio
Formula: (Current Assets - Inventories) ÷ Current Liabilities
Ideal ratio: 1:1 or higher
Tips to Improve Liquidity
- Improve receivables management
- Sell unnecessary hard assets
- Provide financial transparency to investors/banks
- Optimize inventory management
- Establish credit lines for emergencies
Strong liquidity management ensures your business can meet its short-term obligations and take advantage of growth opportunities when they arise.